Q1 2018 Portfolio Discussion: Investing in the US
US equities have had a fantastic run since 2009. We believe we are now in the late stage of the economic cycle. In the final stages of an economic cycle equity returns have historically been very strong.
The US economy is late cycle but a recession does not seem imminent
- US unemployment has fallen to very low levels. Historically, such low levels of unemployment have been a warning sign that we are late in the economic cycle.
- However, wage growth has tended to accelerate at the end of a cycle, causing a more aggressive monetary policy tightening than we have seen so far this cycle. The recovery could well continue until wages accelerate, causing the Fed to tighten too much.
- We expect unemployment to keep falling, wage growth to start rising and interest rates to keep rising in 2018, but at a very gradual pace.
Guide to the Markets - UK, page 22
Warning signs are not yet flashing red
- While we are probably getting closer to the end of this economic cycle, we do not think we are there yet. Historically, the number of people claiming benefits in the US has started to rise before a bear market, and that hasn’t happened yet.
- Business surveys, such as the ISM manufacturing survey, are likely to fall in 2018, if history is any guide. However, while this means the pace of economic growth may slow, bear markets have tended to require the ISM business survey to fall below 50, indicating economic contraction rather than just slower growth.
- The conference board’s leading economic indicator has fallen before every recession in the last 50 years and has acted as a helpful canary in the coal mine for US equities. Currently, this leading indicator paints a positive picture for the US outlook.
Guide to the Markets - UK, page 46
Historically, investors have benefitted from the strength of late-cycle returns
- Many investors have been surprised by the strength of US equity returns in 2017. However, strong returns in the last few years of an economic cycle are the norm, not the exception.
- The columns on the right of the table show that in the final year of a bull market, equity returns have never been less than 15%.
- In the final two years of a bull market, the median return has been nearly 40%.
Guide to the Markets - UK, page 50
- We believe we are in the late stages of the US economic cycle but not yet at the end.
- Historically, equity returns in the late stage of the economic cycle have always been very strong.
- Equity markets have tended to peak only once the economic data start to indicate the economy is heading into recession; warning signs that warned of past recessions and bear markets are not yet flashing red.
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